After debating for days whether the U.S. is going into an economic downturn, Washington policy makers and Wall Street investors on Wednesday barreled into an even more difficult problem: There are few good options to deal with one if it happens.

With short-term interest rates already low, the Federal Reserve has little room to cut borrowing costs to spur spending and investment as it usually does in a slowdown. Meantime, the federal debt is exploding, which could hamstring any efforts to boost growth with tax cuts or spending increases.

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Further complicating matters, Democrats and Republicans strongly disagree about how best to rev up the economy, with Democrats favoring higher spending and the GOP wanting lower taxes. Even within their own ranks there are disagreements about what course to take.

President
Trump
on Wednesday backed away from pursuing new tax cuts, a sharp reversal from a day earlier, when he described several such measures the White House was contemplating. Mr. Trump is in the awkward position of calling for economic stimulus at the same time he says the economy is strong.

“I just don’t see any reason to,” Mr. Trump told reporters at the White House when asked if he was contemplating tax cuts. “We don’t need it. We have a strong economy.”

He dismissed an idea he floated Tuesday: lowering capital-gains taxes by indexing investment gains to inflation. “I’m not looking to do indexing,” he said. “I think it will be perceived, if I do it, as somewhat elitist…I want tax cuts for the middle class, the workers.” He added that it was an option, but “not something I love.”

The government typically uses three tools to help ward off a recession. But with these already in play to help prop up the economy, the Trump administration may have reason to worry. WSJ's Gerald F. Seib explains. Photo: AP

On Tuesday, speaking to reporters in the Oval Office, the president said he had been “thinking about payroll taxes for a long time” and that indexing was “something I’m thinking about.” He added, “I would love to do something on capital gains.”

White House officials, meanwhile, said the administration has long been examining a range of tax cuts as part of what Republicans have termed “Tax Cuts 2.0,” though no proposals are expected imminently and such a measure is unlikely to go anywhere in Congress.

The president also has been pressuring the Federal Reserve to cut interest rates at a clip typically only seen when the economy is severely struggling. On Wednesday morning, Mr. Trump compared Fed Chairman
Jerome Powell,
his own choice for the post, to a “golfer who can’t putt.”

Though unemployment remains exceptionally low, economic growth and hiring have slowed in recent months and some warning signs are flashing in bond markets. Most notably, long-term interest rates at times have dipped below short-term rates, something that has telegraphed recessions in the past and spooked investors in recent weeks.

Wednesday’s economic reports included some troubling new signs. U.S. job growth was weaker in the year through March than previously thought, government economists said. The Labor Department lowered its estimate of total U.S. employment in March by 501,000, or 0.3%. That brought down the average monthly increase in payrolls over the period to about 168,000 from 210,000—still solid but not as robust as once thought.

Other government data revisions in recent weeks also pushed down estimates of growth and corporate profits.

But it wasn’t all bad news: Sales of previously owned homes picked up in July, the National Association of Realtors said Wednesday, a sign that lower mortgage rates may be driving sales after a weak spring selling season. Some retailers also reported good profit numbers, another sign that households remain a pillar of the economy.

The Dow Jones Industrial Average rose 240.29 points Wednesday, or 0.93%, to 26202.73. It had surpassed 27000 in July, when downturn worries started to concern investors.

Academic research cited by top Fed officials in the past says that the central bank should move quickly to cut short-term rates in moments when it has little room to maneuver and the economy might be heading for a slide.

The Fed’s target rate is just over 2%, leaving far less room to cut aggressively than in the past. But officials at the central bank aren’t yet convinced that drastic action is needed. Moreover, the Fed’s ranks are divided about what steps to take.

Fed minutes from its July 30-31 meeting released Wednesday showed several officials favored holding rates steady because they judged “that the real economy continued to be in a good place.”

Two of those officials, Boston Fed President Eric Rosengren and Kansas City Fed President
Esther George,
dissented from the decision to cut rates by a quarter percentage point. But two other officials, not identified in the minutes, favored a more aggressive half-point cut, which they said would better address “stubbornly low” inflation.

The minutes also showed the officials believed uncertainty surrounding the Trump administration’s trade policy wasn’t likely to let up anytime soon, creating a “persistent headwind” for the U.S. economic outlook.

Many business executives have said the uncertain outlook for U.S. trade policy could be holding back the economy. With the U.S. locked in sharp disagreements with China over a range of issues, that might not get resolved soon.

Mr. Powell disappointed some investors—and the president—at his news conference after the July meeting when he pushed back against market expectations of a more vigorous series of rate cuts to follow.

“Now we know why Powell had a hard time at the press conference. There wasn’t a clear consensus,” said
Diane Swonk,
chief economist at Grant Thornton.

Washington’s appetite for budget deficits could be tested by a slowdown or recession. Federal spending tends to rise in a recession because mandatory payments on programs like unemployment insurance goes up. Meantime, tax receipts tend to slow as household income growth and business profits slow or decline.

On top of all of that, cutting taxes or increasing spending to kick-start growth could be a challenge since both can boost deficits. Federal deficits are projected to grow much more than expected over the next decade thanks to the two-year budget agreement lawmakers and the White House struck last month, the Congressional Budget Office said Wednesday.

The agency boosted its forecast of cumulative deficits over the next decade by $809 billion, to $12.2 trillion. That means an additional $12 trillion of debt on top of the $22 trillion already outstanding.

The CBO said the new agreement, which increased spending roughly $320 billion over the next two years above previously enacted spending caps, will add roughly $1.7 trillion to deficits between 2020 and 2029. That reflects CBO’s assumption that federal spending will continue to grow at the rate of inflation after 2021.

Deficits as a share of gross domestic product are expected to average 4.7% over the next decade, up from the 4.3% average CBO projected in May, and a significant increase from the 2.9% average over the past 50 years.